Recently, a wave of lawsuits have been filed relating to the handling of forfeited 401(k) money. According to the legal community, the outcome of the litigation rides on the terms used in the 401(k) plan documents.
The forfeiture lawsuits are focused on the portion of an employee’s 401(k) account that comes from employer contributions. These differ from contributions made from an employee’s salary which are prompt and fully vested. In contrast, employer contributions can stay unvested for a period of time and can be forfeited in whole, or in part, based on when an employee leaves the company (i.e., a few months or years). Here is where it gets murky.
Noncompliance with the Employee Retirement Income Security Act (ERISA)
Where a possible breach of ERISA can occur is when an employer uses discretion over the forfeitures to benefit the organization rather than the employee. For example, an employer might choose to use the forfeitures to decrease the money they would otherwise be paying in contributions to the plan rather than to reduce employees’ administrative costs. While using forfeitures to reduce employer contributions is a routine practice, the current lawsuits suggest that it may go against ERISA’s intents. Some attorneys cite the plan terms as being an important deciding factor.
The 401(k) Plan Terms
The terms of a 401(k) plan can specify how forfeited money from a 401(k) plan can be applied, for instance, to cover administrative costs or for employer contributions. Some plans, however, are specific in stating how forfeitures must be used and prioritize the order of those uses, while others are ambiguous and unclear. Several of the pending lawsuits raise concerns over the discretion afforded the employer by the plan regarding the use of the forfeitures. Some attorneys hold that a lawsuit regarding the use of forfeitures toward contributions could be viable, but only if the plan document required the money to go toward administrative expenses. On the other hand, a lawsuit could be difficult to advance if the forfeitures were being used in a way not anticipated by the plan document/terms. In all cases, it is important that plan sponsors consult with their legal counsel to make certain their use of forfeitures is consistent with the plan terms.
How Fiduciary Responsibilities Factor In
Under ERISA, plan fiduciaries must act in the best interests of the plan participants. The current litigation suggests that fiduciaries with discretion as to the use of forfeitures to lower participants’ costs are in breach of their duties when the money is used to lower expenses. Employers, however, are not mandated to provide retirement plans, nor meet a certain level of compensation guided by set legal parameters. How a plan is designed is integral to this discussion regarding fiduciary responsibilities. Further, some attorneys note that just because an employer can decide how to use 401(k) plan forfeitures, it does not follow that the employer is acting as a fiduciary based on ERISA. The Internal Revenue Service (IRS) also concludes that employers have a choice on how forfeitures are used.
Depending on how the current lawsuits against the named defendants proceed and their outcomes, we can expect additional lawsuits against 401(k) plan sponsors across organizations of diverse sizes and industries. It is therefore wise to consult with counsel and review the 401(k) plan terms to ensure the plan sponsor is acting in compliance with ERISA.
